Taxes, Money and Surpluses: Fact and Fiction

John Stone's somewhat harsh criticism of the Howard government's fiscal policy
was fully justified. (Mr Costello's repeated budget failure, National
Observer No. 73 - Winter 2007). However, Stone's comments on government
revenues and budget surpluses missed a very important question: what generated
such huge government revenues and massive surpluses? There was a time when
the answer would have been self-evident to any economist worth his salt.

From March 1996 -- when Howard won his first general election -- to October
2008 currency increased by 111 per cent, bank deposits by 180 per cent and
M1 (currency plus deposits) expanded by 164 per cent. This is an astonishing
and unprecedented monetary expansion. Yet it is totally ignored by our commentariat,
including those who are supposed to have some economic training. It has become
increasingly clear that for these people -- and I include Treasury and Reserve
Bank officials -- money does not matter with respect to economic activity.
I would go even further and say that they do not even have a working definition
of money let alone any concept of its nature.

It's as if the great debate on monetary policy that is known as the "bullion
controversy" never took place. One thing is for sure, the wisdom that flowed
from that debate has long since been lost to the vast majority of the economics
profession. The result has been the inability of economists to link Australia's
current account deficits and mounting foreign debt to the Reserve's reckless
monetary policy. This has led economic illiterates like Simon Crean, Federal
Trade Minister, to declare that the current account deficit is a structural
problem that requires -- you guessed it -- more government interference and
increased spending.

(If our self-appointed guardians of the free market were in truly acquainted
with economic history and the history of economic thought they would have no
problem dealing with Crean's economic nonsense).

Stone called for tax cuts and a reduction in the number of tax scales. Sticking
strictly to the economics of the proposals -- worthy as they are -- we will
find any number of commentators, particularly in the media, arguing that cutting
taxes, including capital gains taxes, will increase spending which in turn
will worsen the current account deficit and fuel inflation, forcing the reserve
to raise interest rates. Complete and utter tripe.

Let us make this so simple that even a journalist can understand it. If tax
cuts are offset by cuts in government spending aggregate spending remains unchanged.
If the cuts are offset by increased borrowing from the public aggregate spending
still remains unchanged. However, if the government inflates the money supply
to pay for the cuts then -- and only then -- will we get inflation.

But note: it is not the cuts that generate the inflation but monetary expansion.
Expanding the money supply stimulate economic activity and raises nominal incomes.
This increases the government's revenue stream. So long as government expenditure
lags behind the growth in revenue surpluses will continue to emerge. This is
how the Howard government accumulated massive surpluses. Good economic management
had nothing to do with it.

It follows from the above reasoning that if surpluses have been kept by the
Reserve as idle balances then using them to fund tax cuts would have the same
consequences as a monetary expansion. As for investing these surpluses, as
some people suggest, this could act as a form of "forced savings" which would
probably result in the funding of unsustainable projects. The best thing the
Labor Government could do would be to pulp these dollars.

It is to be deeply regretted that some of the issues that I raised will not
be publicly debated.